Wednesday, 8 May 2013

A Primer to Life Insurance Policies

A myriad of insurance schemes have hit the markets over the last decade, most of which aren't exactly insurance. Over the last decade, insurance has become more of an investment avenue than what it was meant to be, all the ULIP schemes and pension like schemes bear testimony to the statement. Of course, each has its merits and demerits and I shall attempt to list these down to facilitate your decision making or draw suggestions from you. There is quite a variety of schemes out there, and I shall list some of the most popular ones:

1. Term Insurance Plan.
This is the vanilla insurance scheme, which provides cover for your life(and whatever riders you attach to your plan) by funding your dependants. In case you do not die(or any of the rider clauses aren't met) over the tenure for which you are insured, you do not receive any money. If you are going for one of these, try to get the online schemes from reputed firms since the premiums are lesser. Check the claims ratio for the firm as well, higher the better.

Separates investment from insurance, gives clarity to your goals.
Huge cover for small premium amounts(compared to other options).

Provides zero return if policy holder survives(or rider clauses not met).

2. ULIP - Unit Linked Insurance Plan
This is more like a mutual fund with the benefit of insurance plan(hence tax benefit) attached to it. The insurance cover is negligible and the fund management fees are astounding during the first year. The premiums paid go towards the fund management fees and the investment in the market. The portfolio breakup for the fund corpus is generally declared in the document(of course, with the clause that it is subject to change). There is generally a lock-in period associated with these schemes as well. Also, there is often a clause of bonus returns, wherein, in case of good fund performance, the policy holder is rewarded with better returns on the investment.

Possibility of better returns exists.
Provides tax benefits on investments in the equity markets.
Funds can be liquidated partially(read terms and conditions for this)

Risk bearing investment, susceptible to losses
Very low insurance cover, can't really be called a good insurance scheme.

3. Pension/Retirement Insurance Plan
This generally requires you to pay premiums until your retirement age(or an age of your preference, as long as it falls within their predefined age limits), and post retirement(or that age) you get regular income(fixed value or it may increase at a predefined interest rate) from the company. In case of death prior to all the premium payments, your family will receive the regular income from the company. This scheme can be used as mentioned above, or it can be used to meet some future financial goals. One needs to do some hard calculations before opting for such schemes For example, if you are paying $10000 annually towards such a scheme for the next 12 years and you are to receive $20000 from the 13th year, compounded annually at 5% from the 13th year, it is up to you to evaluate and deduce whether $20000 will suffice for a year 10 years down the road(values taken are only for example scenario). Of course, this might work in countries with low inflation rates but it would be difficult otherwise.

Provides steady income along with insurance benefits.
Adequate calculations required at the time of premium selection for future planning.
Low risk investment.

Can fall prey to high inflation rates and low interest rates.
Generally yields low returns.

Honestly, in my opinion, it would be best to go for a Term Insurance Plan at a young age, when the premiums charged are low, and take it over the longest term possible. After a decade or so from the first Term Insurance policy, take another Term Insurance policy. This should seal the deal for your dependants I suppose. With the internet era, and the online schemes charging lower premiums, this should be a good option.
If you haven't accumulated wealth for retirement through other means, then you can go for the Pension Insurance Plan, about two decades or less prior to expected retirement age. By that time, you would be quite comfortable with your earnings and such an investment wouldn't probably hurt. I would, however, suggest that instead of going for the Pension Plan, you could just buy a flat or two, and rent them out. They would quite comfortably cover you for the month(of course, you'll have to plan the flat purchase well).
As hard as I try, I can't  find a valid justification for a ULIP. Even for an investor, a good mutual fund would be a better option than a ULIP. One might argue that the absence of capital gains tax for ULIP beats mutual funds, but one would have to calculate the tax against the fees paid to the ULIP fund manager. And as far as insurance goes, ULIP provides the worst cover. If you can think of a reason why ULIP is a good option, please do enlighten me.

Added a flowchart below to summarise everything above, hope it helps.